Bruce Linton in a Canopy Growth facility in Smiths Falls, Ont., on Sept 21, 2018. FRED LUM/THE GLOBE AND MAIL

On its quest to dominate the global cannabis market, Canada’s Canopy Growth Corp. deployed a very deliberate strategy: Entice investors with a grand vision – something co-founder Bruce Linton had in spades – then endure any turbulence en route. Short-term losses were irrelevant. The destination was all that mattered.

It was a winning formula for nearly a decade. Even when investors lost faith in many cannabis producers, and later, when the pandemic nearly decimated the industry, Canopy consistently found a way to float above the fray.

That has all changed, and quickly. In the past two months, Canopy has encountered something much more ferocious than turbulence and its once-faithful investors aren’t sticking around. For the first time, the company’s bottom is close to falling out.

The rout started in late May when Canopy, once Canada’s top LP (or licensed producer) of cannabis by market share, reported yet another batch of ugly earnings. Executives had promised the company would make money by the second half of the year, at least after excluding certain costs, but as that deadline approached, they admitted that any semblance of profit was still at least two years away.

With Canopy bleeding cash, the company’s debt load suddenly began to draw more attention. To alleviate the burden, management announced in June that they would swap some bonds for shares – but the fix only caused more damage. Handing out new stock diluted existing shareholders and as part of the swap, Canopy agreed to repay $345-million in cash next summer. Investors revolted.

In June alone, Canopy’s shares tumbled 42 per cent. Over the past year, they are down more than double that.

To the naked eye, this collapse may not seem all that unusual. Canada’s entire cannabis sector is reeling. The market peak was in September, 2018, a month before recreational cannabis was legalized. Four years later, many mid-tier producers have merged with rivals simply to stay alive. Canopy’s share price has collapsed from $67.74 on Sept. 7, 2018 to $3.39 as of Friday’s market close.

That Canopy would be indistinguishable from the rest of the lot was once unfathomable. It was the first mover. The disciplined producer that didn’t make reckless acquisitions. The one that would last.

“It’s a monumental fall from grace,” said Nadine Sarwat, an equity analyst at Bernstein.

The recent spiral is particularly bruising for Constellation Brands Inc., the U.S. alcohol giant that invested a total of $5.2-billion in Canopy back when it seemed like recreational weed could be the next big thing. The value of that investment is now close to a goose egg – so immaterial that Constellation is hardly ever asked about it.

Because the broader cannabis sector is already in disarray, Canopy’s crash has barely been scrutinized – it’s just another cannabis dream dashed. But in many ways the company’s undoing is the industry’s most important story to tell. That’s because Canopy was the one company that attracted the so-called smart money – the investment that legitimized the entire sector.

There isn’t an easy explanation for Canopy’s demise. Instead, there are a few schools of thought. They fall into three buckets: irrational investors, regulatory hurdles and cruddy management.

The investor angle is the least disputed. The cannabis sector gained steam right after the commodity super cycle crashed in 2012. At that point, tech stocks and cryptocurrencies were not yet mainstream. Weed was the only speculative sector to bet on, and Canada was the only major country that was ready to legalize recreational use. The money poured in.

Against that backdrop, Canopy, led by Mr. Linton, was the undisputed star. Unlike some competitors who were late to the game, Canopy had launched in 2013 as Tweed Marijuana Inc. Its original goal was to sell medical marijuana. Because of this history, the company was well positioned to capitalize on the federal Liberals’ legalization plans. Crucially, Canopy owned a large manufacturing facility – a former Hershey chocolate factory – in Smiths Falls, Ont., southwest of Ottawa.

Few countries had publicly listed cannabis stocks. As Canada’s cannabis profile rose among international investors, Canopy seemed untouchable. In 2017, it was the first marijuana producer added to the S&P/TSX Composite Index, and the very same year, Constellation invested $245-million for a 9.9-per-cent stake.

But Canopy could only control so much. As the October, 2018 legalization date neared, dozens of LPs received regulatory approval to start growing and selling cannabis, which meant Canada was on the cusp of being flooded with weed. Investors refused to do the simple math that would have spelled this out, or simply ignored it.

“There was a huge disconnect between the fundamental values of these companies and their valuations,” said Matt Bottomley, an analyst at Canaccord Genuity.

Oversupply wasn’t the only thing investors glossed over. At the height of the frenzy, hardly anyone stopped to consider the way the companies’ growth would be limited by regulations.

For one, cannabis producers in Canada have to obey strict limits on how they market their products. Health Canada prevented producers from advertising their brands to minors, which took traditional marketing avenues such as major sporting events off the table. Because the rules were so stringent, producers tended to play it safe by advertising with only oblique references to cannabis.

Another hurdle: Cultivation rules have evolved. Early on, producers with the most sophisticated greenhouses were thought to have the best chances at success, because Health Canada enforced so many rules related to pesticides and optimal growing conditions. That’s why Canopy’s archrival Aurora Cannabis spent so much effort publicizing the massive greenhouse it was building near the Edmonton airport, dubbed Aurora Sky.

Only a few months after legalization, Health Canada permitted outdoor growing, which is a much cheaper form of cannabis production. By early 2021, the regulatory body had approved 110 licenses to cultivate outdoors.

Costly greenhouse production, coupled with an oversupply of cannabis, put producers in a bind. Under pressure to slash costs, Canopy shuttered two big British Columbia production facilities in March, 2020, both of which were once marketed as crucial to its expansion.

In May this year, Aurora shut Aurora Sky. The company’s shares have plummeted 99 per cent since their 2018 peak.

Complaints about Canopy’s management are more contested, partly because there are two different teams to blame. Mr. Linton once had his fingerprints on pretty much everything, making him an easy scapegoat, but Constellation fired him within a year of making a second investment, in August, 2018, this one worth $5-billion. Now, deciphering who is responsible for what isn’t so clear cut.

Canopy’s pivot to what is known as Cannabis 2.0 is a perfect example. When it became clear the Canadian market was going to be oversaturated with traditional bud – known as flower in the industry – derivative products became all the rage. “When it came time to launch edibles, vapes and beverages, Canopy wasn’t ready. But their peers were,” said Andrew Carter, an analyst at Stifel Financial Corp.

The groundwork for this pivot should have been laid when Mr. Linton was chief executive.

What is undeniable is that, when he was in charge, he wasn’t content with simply running a Canadian business. He had dreams of global domination. Under his leadership, the company made investments in over a dozen countries. This vision was central to Canopy’s appeal: If cannabis legalization swept across the globe, it would arguably be the best situated to capitalize.

But cannabis bans weren’t so quick to disappear. Spreading the money left Canopy looking like a sprawling octopus, miles from water.

The walls closed in on Mr. Linton after Canopy reported a $323-million fourth-quarter loss in June, 2019, four times larger than analysts’ expectations. By then it was clear the international bets would take years to pay off, and that Canada’s cannabis experiment had gotten off to a slow start.

Six months after legalization there were major supply-chain issues and weak sales across the industry. Investors may not have cared about profits in the early days, but eventually they did. Mr. Linton was fired in July, 2019.

To this day, he doesn’t regret his strategy. He argues that success comes only from expanding and innovating. “I could have been profitable in year three, but you know what? By year four you would have been irrelevant,” he said in an interview. The industry was evolving so quickly that he worried about thinking too small and quickly getting eclipsed. So he dreamed big. “This platform was not built to be a corner participant in a small segment of the market.”

Canopy declined to comment for this story because the company reports earnings this week, but the current management team – and Constellation – have often implicitly suggested that Mr. Linton should bear the brunt of the blame. The way they frame it, Canopy has spent the past three years slashing costs Mr. Linton approved.

But Constellation was well aware of what Mr. Linton was up to. When the American company bought its first, smaller stake in Canopy in 2017, it wasn’t solely a passive investment – Canopy referred to it as a “strategic relationship,” with Constellation providing support on consumer analytics, market trending, marketing and brand development. A year later, they doubled down with that $5-billion cheque.

Constellation has made its own blunders since taking the reins. After firing Mr. Linton, the new chief executive, David Klein, who used to be Constellation’s chief financial officer, made it clear he was betting on the U.S. market. After Joe Biden won the presidency and the Democrats took 50 seats in the U.S. Senate, there was enormous hope in the Canadian industry that cannabis would be legalized at the federal level.

Now, with Republicans seemingly poised to retake the Senate in mid-term elections this fall, those dreams have all but disappeared. “Some assets in Canopy’s portfolio have value, but we believe [the company] has built a strategy dependent on U.S. legalization, where prospects have worsened,” CIBC World Markets analyst John Zamparo wrote in a recent note to clients.

Mr. Carter at Stifel is also critical of what he calls Constellation’s capital markets strategy. Its plan was to invest $5-billion in Canopy, then use that money to grow through acquisitions. The plan backfired. Instead of putting Canopy alone in a position of strength, the investment ended up being a shot in the arm for the entire industry. The sector’s share prices soared in the aftermath, making potential deals much more expensive.

Mr. Carter was also baffled by Canopy’s decision to take on costly debt in April, 2021, in the form of a US$750-million loan from King Street Capital Management LP, a U.S. investment firm. At the time, Canopy’s shares were experiencing a resurgence because retail traders had piled into speculative stocks. Other cannabis companies were raising money by selling shares, but Canopy chose debt.

“It just made no sense. Why would they do it? I don’t know. I still don’t get it,” Mr. Carter said of the loan.

From afar, it can seem like Constellation has barely been hindered by its bad bet. It was a $5-billion blunder, yet most analysts have moved on and the company’s shares haven’t tanked. On its last quarterly call, Bernstein’s Ms. Sarwat was the only person to ask about the disaster.

In an interview, she said Constellation has, in fact, been penalized, but it’s hard to recognize because the Canopy pain has been masked by Constellation’s beer portfolio, which includes the U.S. marketing and production rights for Mexican beers such as Corona. It’s one of the bright spots in the alcohol industry.

This past spring, the Sands family, which controls Constellation, announced they were giving up their special class of voting shares in the company. The motivations for the move have been tough to decipher. Perhaps the family just wants to cash out – the Class B shares are getting bought for a total of US$1.5-billion.

But Ms. Sarwat has an alternative theory: Ordinary shareholders were getting fed up, particularly with rumours swirling of new acquisition targets, and they wanted a greater say in the company’s future. “People were worried they were going to do another stupid deal,” she said.

Canopy, now run by Constellation’s chosen leaders, is trying to turn a corner. It laid out a revitalization plan in May. In Canada, its focus is on premium cannabis, a response to the country’s oversupply of cut-rate mediocre weed. Canopy also plans to cut even more expenses – particularly sales, marketing and general costs, which it hopes to reduce by 25 per cent. Roughly half of the savings are expected to come from job losses.

Because Canada has far too many LPs, and many are now pivoting to premium weed as well, Canopy’s best hope for growth is U.S. expansion. But even if the U.S. government does legalize cannabis, Canopy has lost what used to be its biggest advantage: a war chest with billions of dollars to burn.

At the end of 2018, Canopy had $4.1-billion in cash on its balance sheet. Now its coffers are running low. Before the recent debt exchange, the company was in a net debt position, meaning it owed more than its cash balance. And growth is hard to come by.

“They’re the furthest of all the large LPs from becoming profitable,” Canaccord’s Mr. Bottomley said.

Key dates in the Canopy Growth story

• April 4, 2014: Launches trading on the TSX Venture Exchange
• May 24, 2018: Becomes the first cannabis company to trade on the NYSE
• Aug. 15, 2018: Constellation Brands announces it will invest $5-billion for an eventual 38-per-cent share of Canopy
• Sept. 7, 2018: Canopy reaches an all-time share price high of $67.74 a share
• Oct. 17, 2018: Cannabis becomes legal in Canada for recreational use
• April 18, 2019: Canopy is added to the to the S&P/TSX 60 Index
• July 3, 2019: Founder Bruce Linton is ousted from company
• Dec. 9, 2019: David Klein, a former Constellation Brands executive, is announced as Canopy’s new CEO
• Dec. 20, 2019: Mark Zekulin, former co-CEO, steps down
• Dec. 9, 2020: As part of the new restructuring plan, Canopy announces it will close five facilities and cut 220 jobs
• March 18, 2021: Canopy announces it is raising US$750-million through a senior secured loan
• Feb. 5, 2021: Pandemic investing boosts Canopy stock to a two-year high of $54.76
• June 30, 2022: Canopy announces it will swap $255.4-million of its senior secured notes for shares and cash

TIM KILADZE AND IRENE GALEA
The Globe and Mail, August 2, 2022